Market Thought... market evaluation

The most sensitive sectors to a global slow down or US recession are arguably Energy, Materials, Industrials, Consumer Discretionary and Financials. As of 09/30, here is the breakdown in percentage terms.

SP

10,303,141.34

% of SP

energy

1,198,111.00

11.63%

Materials

345,943.83

3.36%

Industrials

1,058,277.07

10.27%

Financials

1,399,986.67

13.59%

con. dis.

1,097,132.98

10.65%

Current estimates for the 2011 SP500 earnings are $98. I do not know the exact %-breakdown of component earnings, so I used the above percentages to assume their contribution to the $98 estimate.

At the moment, to gain a realistic estimate reduction, I used information companies have already eluded to. For instance, for the most part earnings have been holding up well with solid forecasts, and solid warnings. However, it should be noted, the warnings are mostly coming from material (or commodity) related companies, and their warnings have been severe. Arch Coal cut estimates by some 50%, so I used a 50% reduction for material's earnings. I used a 20% reduction for energy just because oil came in some 20%. I used 40% reduction for Industrials because of Ingersall-Ran's crappy report. (Although I will stress this is conservative as their issues maybe company specific, as this quarter was a continuation of a previously crappy quarter.) I used a 30% reduction for financial as their earnings have already come down quite a bit. And I used only a 10% reduction in consumer discretionary because, quite frankly we don't see evidence of hits, other than declining stock prices.

SP

10,303,141.34

% of SP

98

% reduction

$85.01

new end of year estimate

energy

1,198,111.00

11.63%

$11.40

20.00%

$2.28

Materials

345,943.83

3.36%

$3.29

50.00%

$1.65

Industrials

1,058,277.07

10.27%

$10.07

40.00%

$4.03

Financials

1,399,986.67

13.59%

$13.32

30.00%

$3.99

con. dis.

1,097,132.98

10.65%

$10.44

10.00%

$1.04

$12.99

earnings reduction

By the end of 2011, lets assume a reduction of $12-13 of eps. That leads us to a SP500 eps estimate of $85-86. In 2010, the SP500 had an eps of $84. So, the above assessment is assuming no eps growth, which would justify a low range multiple for the SP500. The SP500 multiple usually trades between 12-15. With a 12 multiple on earnings of 85-86, places a 1020-1032 target on the SP500.

Currently 2012 eps estimates are at $110. If the countries with plenty of room to ease (BRICs), will start easing, will the SP500 earnings start to grow again? (I think that is what the market is saying with the relative strength of IBM and oil, but lets assume that is my imagination.) Lets assume a zero global GDP growth environment, however unlikely, which will allow us to assume a 2012 eps of $86. But in 2012, the negativity should ease up (if only for a bit) as the US rotates out of this 'leading indicator' recession. So we should see a multiple closer to 14 in 2012, which would suggest a SP 500 target of 1204 (14 x $86).

So this is the premise to which I will be currently trading with. However, I also fully understand while the US maybe entering a "leading indicator" recession, oil prices are telling me global GDP will not contract. We had one global GDP contraction since the great depression, and that was due to the great recession. With out a shock to the system, we will not see global GDP contract.

Keep in mind, I did the above to understand how the big boys are thinking, and what justifications they will use to value equities. I am still under the belief that over the last 10 years the largest American companies have diversified their earnings so much that the SP500 index should be correlated to the global GDP, not US GDP. And with out a GLOBAL recession, I think the above estimates are grossly, grossly, conservative. (With the exception of the materials space.)

As for the technicals, the SP500 lost its trading dynamic from the March 2009 rally, so I do not put any importance on any technical support. Once we establish a new base, that will be the beginning of a new rally, and new trading dynamic. However, the 1050 level, corroborates with the above numbers.